Foreign Exchange Markets: Overview of the Special Issue

Abstract

Researchers in the field of foreign exchange markets have worked hard to understand the behavior of nominal and real exchange rates and the mechanics of the markets in which nominal exchange rates are determined. JIMF has played a continual role in this process, via both the research that it has published and the conferences that it has sponsored to bring researchers together to share ideas. The purpose of this special issue is to extend these lines of research and to create fruitful avenues for further academic work on the subject. The three papers in this issue that deal with uncovered interest parity, although they do not solve the UIP puzzle completely, provide some important pieces to it. They demonstrate that our understanding of UIP increases considerably when we either take into account data for more recent years, longer horizons or emerging markets, use survey data to measure anticipated exchange-rate rather than actual values, use models that allow for nonlinearities in the UIP relationship, or incorporate heterogeneous beliefs into models of bond prices. The two high-frequency studies of exchange rate fluctuations contained in this special issue reveal important effects of oral interventions by monetary authorities as well as of a much wider array of news events than previously reported. They thus add to the new second-generation body of high-frequency literature, which goes beyond pure description of the data to try to discover the links between traders’ behavior and the flow of economic information. This literature, as two of the more prominent contributors to it have recently argued (Evans and Lyons, 2005), is now beginning to supply some major pieces to the ‘‘exchange-rate disconnect’’ puzzle. Thus providing evidence of macroeconomic influences on exchange rates at short horizons of the sort that the PPP studies have provided at much longer horizons. Further empirical evidence presented in this special issue indicates that realistic exchange rate premia can be obtained using asset pricing models, that both the probability and the extent of currency crises are related to institutional factors as well as country-specific economic factors and that, in what amounts to a new puzzle of sorts, differences in exchange rate volatilities between developing and industrial countries cannot readily be ascribed to differences in real and nominal shocks.

Keywords: Foreign Exchange Markets, Exchange Rates, Purchasing Power Parity, Uncovered Interest Parity, Monetary Policy

JEL Classification: F31, G15, E52